Is Apple Watch A Threat To Fitbit's IPO?

Fitbit, the fitness tracking device maker, plans to sell shares on the New York Stock Exchange. Should you buy some or is Apple Watch too much of a threat? I think you should wait until six months after the IPO and decide then.

I have no financial interest in Fitbit -- though I have been turned down twice in my efforts to invest over the last year. Sadly, I was able to invest in Allston, Mass.-based Epesi Technologies, a failed "application service provider" of which Fitbit CEO, James Park, was chief technology officer.

Fitbit made a $131.8 million profit in 2014 "on revenue that nearly tripled to $745.4 million. Since 2007, Fitbit has sold roughly 20.5 million of its fitness-tracking devices—from the $60 Zip clip-on to the $250 Surge wristwatch—with more than half sold last year alone," according to the Wall Street Journal.

Fitbit hopes to sell 22.4 million shares, raising $549 million in an IPO priced between $14 and $16 that would value the company at between "$2.9 billion to $3.3 billion," according to BusinessInsider.

Insiders will maintain control of Fitbit after the IPO because they will hold onto Class B shares with 10 times the voting power of the Class A shares that will be sold to the public, according to the New York Times.

The 'Flex', an 'electronic coach', device by Fitbit is presented at the Mobile World Congress in Barcelona, on February 24, 2014. The Mobile World Congress runs from the 24 to 27 February where participants and visitors alike can attend conferences, network, discover cutting-edge products and technologies at among the 1,700 exhibitors as well as seek industry opportunities and make deals. AFP PHOTO / JOSEP LAGO (Photo credit should read JOSEP LAGO/AFP/Getty Images)

When Fitbit goes public, I expect its shares to pop by 20% to 30% thanks to efforts by the underwriters and demand by loyal Fitbit customers. But the question for Class A investors is whether Fitbit can grow its earnings faster than Wall Street expects in future quarters.

As I see it, the balance of investment positives -- market leadership and financial strength -- and negatives -- competition and legal woes -- would make me want to wait before owning the shares in the public market.

Market leadership

Fitbit is the dominant player in the fitness-tracker market. According to The NPD Group, Fitbit had 85% of the U.S. connected activity tracker market, by dollars, up from 70% for 2014 and 59% for 2013.

And the fitness tracker industry is set to almost triple from the $2 billion it reached in 2014 to $5.4 billion by 2019, according to Parks Associates, which sees more people buying these "connected health devices" -- 30% in 2014 compared to 24% in 2014.

Financial strength

Fitbit looks strong financially -- growing 173% in 2014 and enjoying an 18% net profit margin after years of losses -- most recently due in part to its recall of the Fitbit force, according to its prospectus.

Moreover, Fitbit has been boosting its cash -- up $69 million in 2013 and another $114 million in 2014.

Fitbit must repay $137 million in debt interest and principal as well as operating leases within the next year, according to its S1.

But Fitbit already has $238 million in cash and if it raises another $549 million in its IPO, it will be able to meet this short-term obligation without breaking a sweat.

Competition

According to NPD Group, Jawbone Up was a distant second place rival with 19% of the market in 2013.

But the bigger threat comes from larger companies that make smart watches. Parks Associates expects smart watches to account for 68 million of the 135 million connected health device market -- with fitness trackers from the likes of Fitbit representing 50 million of that total.

Apple and Fitbit have parted ways. Until November 2014, Apple sold Fitbit fitness trackers in Apple stores but no longer does. And last October Fitbit announced that it had no plans to support Apple’s HealthKit software because the Fitbit Surge would be a direct competitor to the Apple Watch.

To be fair to Fitbit, the Apple Watch may be at a disadvantage for consumers who prefer a durable, easy to use device that can last many days on a single charge. The Apple Watch is bigger, harder to use, and requires daily battery recharging -- all disadvantages for people who just want fitness tracking, according to SeekingAlpha.

Legal challenges

Jawbone "sued Fitbit in California in May, accusing Fitbit of “systematically plundering” confidential information by hiring Jawbone employees who improperly downloaded sensitive materials shortly before leaving the company," according to the Times.

Jawbone complaint accused Fitbit recruiters of contacting about a third of Jawbone's employees in 2014 and some of Jawbone’s employees decided to join Fitbit. But "before they left for Fitbit, they downloaded confidential information like Jawbone’s business plans to thumb drives, then tried to cover their tracks," according to the Times.

Fitbit's statement said, “As the pioneer and leader in the connected health and fitness market, Fitbit has no need to take information from Jawbone or any other company … We are unaware of any confidential or proprietary information of Jawbone in our possession and we intend to vigorously defend against these allegations.”

Fitbit also has had problems with people developing skin irritation from wearing its Fitbit Force. Speficially, some of its users "experienced allergic reactions -- skin irritation, rashes, and blistering -- to adhesives in the wristband," according to Fitbit's prospectus.

Whether Fitbit is a good public company investment depends on the continued success of its current products and its ability to accelerate profit growth by introducing new products that gain market share.

Don't buy these shares on their first-day pop -- it is better to decide whether to buy after the big lockups expire -- which is likely to create selling pressure -- around six months after Fitbit's first day of trading.